What time do companies buy their own shares? With simple intuition – when they have a market price below a fair price … though there are some interesting nuances here:
When the organization has excess money, it can:
- Invest in positive NPV projects
- Return to the loan and improve the leverage
- Distribute dividends
- Repurchase shares
The choice between these alternatives gives signals to the market.
If the company fails to find positive NPV projects, it will collect excess money. But keeping money is annoying to Mr. Market.
If the loan is repaid with excess money and Leverage is overwhelmed, it will reflect the pessimistic mood of management. So, it’s not a best signal …
If you distribute dividends with excess money, it will be a very good signal for investors. Especially when the company firstly decides to distribute dividends. However, dividends are associated with a long -term commitment… This is such a painful moment for management that they usually are ready to take any risk but not let dividends to miss… that is why they make the decision to repurchase shares rather than distribute dividends.
The repurchase of shares is equivalent to dividend distribution in its content and has no long-run significant influence on share prices – the cash drain is compensated by the increase in the EPS).
However, repurchase does not mean long – term promise. It is perceived as a one-time fact, and a positive signal to the market – management is hopeful and is responsible with excess money …
P.S.
Finally, it has to be said that the loan reduction, dividend or redemption indicates the management responsibility.
Irresponsible managers often invest in excess money in negative NPV projects. This is often due to the personal interests of management, the inability to evaluate or selfish ambitions (Agency Problem). With such inadequate solutions, management often drops the value of the company…
P.P.
According to current data, the redemption of global shares has reached a historic maximum: